The federal securities laws require investment professionals and stockbrokers to make appropriate or suitable recommendations to their customers, based on, among other things, the customers tolerance for risk. The sale of unsuitable investments is a form of stockbroker fraud and stockbroker misconduct. Suitability is based on a customer's age, income, net worth, education, stated investment objectives and prior investment experience.
NASD Conduct Rules require that in recommending to a customer the purchase, sale or exchange of any security, a member shall have reasonable grounds for believing that the recommendation is suitable for such customer upon the basis of the facts, if any, disclosed by such customer as to their other security holdings and as to their financial situation and needs. Despite the temptation to realize excessive returns in the stock market, investors should be aware of risk. Those seeking to double their money in the stock market ought to be prepared to lose it all.
The willful disregard of a customer's stated investment objectives and tolerance for risk through the sale of excessively speculative or volatile securities is a form of stockbroker fraud or misconduct, which is actionable under the federal securities laws.
The sale of unsuitable investments also includes the failure to properly diversify a customer's investment portfolio, or the over concentration of that portfolio in volatile, or speculative technology, telecommunication or other securities, including junk bonds.
Stockbroker misconduct, in the form of the sale of unsuitable investments, also includes the recommendation of low priced or speculative securities, where the stockbroker has misstated or omitted the risks inherent in a particular investment, and thereby took risk that the customer was or would have been unwilling to accept. This is a form of stockbroker fraud or misconduct.The most common examples of unsuitable recommendations by a stockbroker or investment advisor relate to:
› Excessive risk - The recommendation of a risky investment to a customer who is seeking more conservative investments or cannot afford significant losses is a form of stockbroker fraud or misconduct.
› Over-concentration - The recommendation or failure to diversify a portfolio that is over-concentrated in a small number of stocks or one asset class is a form of stockbroker fraud or misconduct.
› Illiquidity - The sale of securities that are illiquid or for which no recognized market exists such as limited partnerships or restricted securities is a form of stockbroker fraud or misconduct.
These obligations on the part of the stockbroker arise out of the "Know Your Customer" Rule.